An Auction House Learns the Art of Shadow Banking

A year before he got caught up in a U.S. money-laundering investigation, Malaysian financier Jho Low was looking to borrow more than $100 million without having to answer all the nosy know-your-customer questions required by U.S. banks such as JPMorgan Chase & Co.

“Prefer the boutique banks that can move fast vs the large ones like JPM,” Low wrote on March 13, 2014, to an employee of a private art dealership that had sold him a painting by Claude Monet for $35 million a few months earlier. The lender “can take all the art no problems,” he wrote the next day. “All in Geneva free port. Speed is the most important and one with a fairly quick and relaxed kyc process.”

Low got his money a month later, not from a bank but from Sotheby’s, an auction house that isn’t subject to the same money-laundering scrutiny by regulators. He pledged 17 works of art, valued between $191.6 million and $258.3 million, to secure a $107 million loan, according to a U.S. Justice Department complaint filed July 20 in an effort to seize more than $1 billion of assets allegedly siphoned from a Malaysian state fund.

As prices for art skyrocketed, Sotheby’s and other firms have become shadow banks, making millions of dollars of legal loans outside the regulated financial system and raising concerns that such financing could facilitate money laundering. Sotheby’s tripled lending to $682 million over the four years ended in 2015. Last year it almost doubled, to $1 billion, a revolving credit facility provided by banks including JPMorgan and HSBC Holdings Plc that it can use to make loans.

Art Crime

“One way to launder is to use art as a security for a loan,” said David Hall, who spent 10 years as a special prosecutor for the Federal Bureau of Investigation’s Art Crime Team and is now a partner at law firm Wiggin & Dana LLP. Hall, who wouldn’t comment about Sotheby’s or the Low case, said the aim is to use ill-gotten funds to purchase assets that can be used as collateral for a loan. “The level of scrutiny you’ll receive from a bank is much higher than you will receive from an auction house.”

Sotheby’s says it has a rigorous compliance program, and the firm hasn’t been accused of wrongdoing in connection with the government investigation. While the company underwrites loans on the basis of the value and title of the artwork, it has a parallel process that looks into a client’s source of wealth and evaluates risk in a manner analogous to banks, according to Lauren Gioia, a spokeswoman. The compliance program is headed by Jane Levine, a former federal prosecutor who worked with the FBI’s art-crime unit.

“This process was in place at the time the loan to Mr. Low was extended,” Gioia said. “As outlined in the complaint, Sotheby’s, like many other entities, including prominent law firms, major banks, real estate companies and corporations in other industries, fell victim to a complex web of transactions designed to hide and disguise the alleged illegal source of funds.”

Indeed, some of the money used to buy Low’s art flowed through a U.S. account at JPMorgan, according to the complaint.

Financing Lifestyles

Art financing has expanded not just at Sotheby’s but at banks including Bank of America Corp. and JPMorgan as well as boutique firms. Art-secured lending has increased by 15 percent to 20 percent annually over the past five years to become a $15 billion to $19 billion market in the U.S., according to Deloitte’s Art & Finance Report 2016.

“There’s no doubt as the market evolves people are looking to finance their lifestyle,” said George Sutton, an analyst at investment bank Craig-Hallum Capital Group LLC. “It’s a way to raise cash.”

But getting such loans has become more difficult as banks have paid hundreds of millions of dollars in fines for violating money-laundering laws. They have to scrutinize the financial lives of prospective clients, a process that can take months and require documentation including tax returns.

Less Scrutiny

While Sotheby’s and other boutique lenders are subject to laws that prohibit money laundering, they’re not covered by the strict reporting requirements of the Bank Secrecy Act or supervised as deposit-taking institutions are by federal banking regulators.

They typically make loans of as much as half the value of the art put up as collateral. Rates are higher than at traditional banks. Sotheby’s charges about 6 percent to 8 percent, according to a person with knowledge of the matter. Because the collateral is art, there’s less concern about a borrower’s creditworthiness.

“I never looked at a financial statement or a tax return to make a loan,” said Mitchell Zuckerman, who started Sotheby’s Financial Services, the firm’s art-lending business, in 1988 and ran it until 2007. “Just because a client is not creditworthy by conventional bank standards doesn’t mean that his art collection doesn’t contain realizable value.”

Zuckerman, who left Sotheby’s this year and is now an art consultant, said in an interview this month that when he started the lending business he visited private banks in London, Tokyo, Paris and Geneva to make this pitch: “If your client can’t satisfy your credit test but has sufficient value in his art collection, you can refer that loan to us.”

The auction house has lent money to dozens of high-flying art collectors in recent years, including newsprint magnate Peter Brant and art-media owner Louise Blouin, according to public filings. Neither has been accused of wrongdoing in connection with the loans.

Much of the money Sotheby’s uses to make loans comes from the credit facility financed by a syndicate of large banks. The weighted average cost of the funds to Sotheby’s was 2.9 percent in 2014 and 2015, filings show.

Cristal Parties

When Low Taek Jho, who goes by the name of Jho Low, arrived on the art scene in 2013, he had already attracted the attention of the New York Post, which described him as “the mysterious Malaysian who likes to surround himself with long-legged models and run up six-figure tabs buying bottles of Cristal.” The paper recounted that the Wharton School graduate celebrated his 28th birthday in Las Vegas, where a swimming-pool party featured caged lions and tigers, and guests included Paris Hilton.

Much of his art was purchased through a company registered as Tanore Finance Corp. and set up by an associate, Eric Tan, according to the Justice Department complaint. That was one of the entities whose accounts at Zurich-based Falcon Private Bank Ltd. received more than $1 billion diverted from the coffers of 1Malaysia Development Bhd., a state investment fund known as 1MDB, the complaint said. Prime Minister Najib Razak was chairman of the fund’s advisory board. According to the filing, which didn’t accuse Tan of wrongdoing, Tan’s only connection to 1MDB was his relationship with Low. Efforts to contact Tan were unsuccessful.

Najib and 1MDB have denied any wrongdoing, and the nation’s attorney general this year cleared Najib of graft over revelations that $681 million appeared in his accounts. Low, chief executive officer of Hong Kong-based investment fund Jynwel Capital Ltd., didn’t respond to requests for comment. He has said he consulted for 1MDB, didn’t break any laws and assisted a Malaysian parliamentary committee probe of the fund.

Basquiat’s ‘Dustheads’

Tanore opened an account at Christie’s, the world’s biggest auction house by revenue, in May 2013, according to the court filing. Over two months, it purchased seven works of art for about $137 million. Some of the money flowed from Falcon Bank through an account at JPMorgan maintained by the auction house, the complaint said. Andrew Gray, a spokesman for JPMorgan, declined to comment.

Two pieces were bought at an auction benefiting the Leonardo DiCaprio Foundation. DiCaprio starred that year in “The Wolf of Wall Street,” a film financed by Najib’s stepson, Riza Aziz, with money diverted from 1MDB, according to the government complaint.

Tanore also bought Jean-Michel Basquiat’s “Dustheads” for $48.8 million, an auction record for the artist at the time and well above the estimated target of $25 million to $35 million. In June, Tanore spent $79.5 million on two paintings — Mark Rothko’s “Untitled (Yellow and Blue)” and Lucio Fontana’s “Concetto spaziale, Attese” — in a private transaction at Christie’s, according to the complaint.

That October, Tan gave at least $131 million worth of art to Low, along with a transfer-of-ownership letter citing “all the generosity, support and trust that you have shared with me over the course of our friendship,” according to the complaint. Low bought other pieces from dealers and at auctions, including a drawing by Vincent Van Gogh and two paintings by Claude Monet, the government said.

Triple Eight

Then, in March 2014, Low started looking for a loan. One month later, he got one from Sotheby’s Financial Services. He pledged “Dustheads,” the Van Gogh drawing and 15 other works, according to the complaint. The loan was obtained by Triple Eight Ltd., a Cayman Islands entity wholly owned by Low, the filing said.

“The number should raise the question: Where did the counterparty get $200 million?” said John Moscow, a former deputy chief of investigations for the New York District Attorney’s Office who’s now in private practice at Baker & Hostetler LLP, referring to the value of the collateral posted against the Sotheby’s loan. “If they don’t ask that question, then the rest of it is a farce. The banks are under legal regulations not to give money to people who can’t explain where they got it. The auction houses don’t have that rule at this time.”

Gioia, the Sotheby’s spokeswoman, said that question was part of the company’s compliance process. She said the auction house is cooperating with the government investigation and limited its transactions with Low to selling the collateral after learning of the probe.

Christie’s Advances

Christie’s doesn’t have a formal art-financing program. It advances money to clients who consign works for auction, using the art as collateral, according to Jennifer Ferguson, a spokeswoman for the auction house.

The advances, which Christie’s says aren’t loans, are typically for three to nine months and have exceeded $10 million, according to a person with knowledge of the matter who asked not to be identified because the information is private. In recent years, Christie’s has had $50 million to $100 million of outstanding advances at any given time, the person said. The company advances as much as 50 percent of the collateral’s low estimate and won’t make money available until it takes possession of the artwork.

Christie’s said in a statement that it has “a rigorous anti-money-laundering compliance program in all countries where we operate.” The auction house said it follows the same protocols as major banking institutions and didn’t advance any money to Low.

“As soon as we became aware that Jho Low was the subject of a government investigation, we stopped allowing him and any individual or entity known to be associated with him to participate in our sales and complied with the government’s request for information,” Christie’s said.

Auction Pipeline

Asher Edelman, a co-founder of Artemus, a New York-based firm that has made loans on about $30 million to $40 million of art, said most of his clients either can’t get financing through a bank or don’t want to put up with the difficulties of dealing with one.

“When you are getting financing through a bank, it’s not really about the art,” he said. “The bank doesn’t give you financing unless you have a substantial balance sheet and cash flow with them.”

In addition to making money on its loans, Sotheby’s has used art financing to generate a flow of artworks for its auctions. During Zuckerman’s 19 years running Sotheby’s Financial Services, about 10 percent of the auction house’s global sales came from loan collateral, he said.

Sotheby’s and Christie’s typically fight to win top-tier consignments, often giving up chunks of their commission for the privilege of selling them. In the case of its loan to Low, Sotheby’s got the works noncompetitively and kept millions of dollars in commission fees when they were sold.

Many of Low’s works sold for less than their purchase price. A 1935 portrait by Pablo Picasso of the artist’s lover, Marie-Therese Walter, fetched $27.6 million at auction in February, a decline of 31 percent from the purchase price. Sotheby’s sold “Dustheads” in a private transaction for about $35 million, according to a person with knowledge of the matter, a 28 percent drop in less than three years.

Even though he took a loss on the sales, Low got the proceeds of the loan.

The goal of money launderers is to create a separation between the ill-gotten gains and subsequent transactions, according to Hall, the former FBI prosecutor.

“You can see how effective this is as a laundering scheme,” said Hall. A borrower “doesn’t need to repay the loan because he just sells the collateral. He ends up with the money that appears to be clean. And he can use it however he wants.”